Simple Illustration On How to Value Stock/Inventories based on the lower of cost and net realizable value (Part 2)

October 15th, 2010 Comments off
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In earlier Part 1, we understand the meaning of net realizable value (NRV) and the principal situations how NRV occurs.

The basic valuation rule for stock or inventories are to value stock based on the lower of cost AND net realizable value(NRV).

Therefore at a periodic timeĀ  the company needs to takes its stock items and compared cost and NRV to fulfil this basic stock valuation rule.

Below a simple illustration where a company has only four inventory on hand at the end of the accounting period:

Stock item Cost($) NRV($) Lower of cost and NRV ($)
A 20 34 20
B 14 8 8
C 43 55 43
D 29 40 29
TOTAL 106 137 100

Salient points to note:

(a) It is wrong to compare the TOTAL costs of $106 with TOTAL NRV of $137 and to state the inventories at $106. If you look at item B, there is foreseeable a loss of $6 and this should be recognized. By adding the TOTAL, the loss in item B will be hidden. But by performing the cost per NRV comparison for each item separately the correct stock valuation is derived re: $100

(b) For a company with large amount of inventory, it is acceptable to group similar items into categories and perform the comparison of cost and NRV category by category rather than item by item.

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